The latest idea out of the G20, that of creating an international regulatory structure for the biggest international banks, sounds like progress but I doubt it will prove to be.

Some regulators took note of the dangers posed by globe-spanning financial behemoths prior to the crisis. The Bank of England, in its April 2007 Financial Stability Report, singled out 16 “large complex financial institutions” as having the potential to put the financial system at risk. It also noted smaller concerns could pose a threat by virtue of their position in key markets.

The Financial Stability Board, the global body that implements the G20’s communiqués and which comprises senior international regulators, has been working on a list for more than a year. The banks on the original list were Goldman Sachs, JPMorgan Chase, Morgan Stanley, Bank of America Merrill Lynch and Citigroup of the US; Royal Bank of Canada; UK groups HSBC, Barclays, Royal Bank of Scotland and Standard Chartered; UBS and Credit Suisse of Switzerland; France’s Société Générale and BNP Paribas; Santander and BBVA from Spain; Japan’s Mizuho, Sumitomo Mitsui, Nomura and Mitsubishi UFJ; Italy’s UniCredit and Banca Intesa; Germany’s Deutsche Bank; and Dutch group ING. Legal experts said the likes of Mizuho, Sumitomo Mitsui and MUFJ could be removed from that list, leaving their oversight to local regulators.

Banca Intesa is on this list and not AIG? Admittedly, this list is construed to be that of banks, but if the Financial Stability Board takes its name seriously, the omission of AIG reveals the same sort of blinkered thinking that enabled the crisis.

The biggest problem with the idea of international oversight is that bankruptcy is still a national affair. Unless the international authority has the financial firepower either to bail out a faltering behemoth or provide it bridge financing while it is being wound down, an international body is likely to merely be a defacto nagger and coordinator of local regulators (financing is often important in the resolution process; the US authority in the S&L crisis, had to get an $50 billion authorization from Congress for working capital, and this was for a passel of little, individually easy to wind down institutions). Indeed, the Financial Times report indicates that most of the work will indeed remain in the hand of national regulators .We have a more passive version of that in Basel III, which are standards that are promulgated internationally but adopted and implemented by national banking regulators.

The G20 also appears about to punt (under the cover of deferring) on one move that might have given an international authority a wee bit of clout, that of putting a surcharge on the activities of banks deemed to be systemically important. The idea of a charge is to provide disincentives against being so large, plus to help fund various remediation activities.

The problem, as the Bank of England’s Andrew Haldane wrote in a must-read paper, The $100 Billion Question, is that global banking as now constituted is economically destructive. There’s no economic justification for banks larger than $100 billion; they are cost inefficient relative to smaller banks (well, actually, there is an economic justification: bank CEO pay is highly correlated with total assets of the bank). Financial crises impose costs on the rest of the economy, meaning innocent bystanders. The output losses of the last crisis were somewhere between 1 and 5 times global GDP. If you take the low estimate, assume a 20 year time frame to recover the costs via a tax, it would require a levy of over $1.5 trillion per year. The market cap of the biggest banks is only $1.2 trillion.

Haldane’s analysis is devastating. It says that finance as now constituted is monstrously destructive. Its social costs dwarf its value as a business. This cost/benefit tradeoff says the biggest financial players need to be radically restructured, or regulated very aggressively. But instead, the Financial Stability Forum spends a year debating who ought to be regulated, a Nero-esque fiddling while financial firms use cheap central bank provided liquidity to hunt for new risky, potentially economy-wrecking adventures.

Given the immovable object of nation-based bankruptcy processes, a seemingly more modest step would actually do more to reduce systemic risk. Right now, capital adequacy is the responsibility of the home country regulator. For instance, aside from certain operations, like broker-dealers (which are regulated on a national level), if banking operations in a foreign country get in trouble, the home country operations are supposed to provide support. Thus, for instance, the TARP infusions were also for the benefit of the overseas operations of JP Morgan, Citi, and the other recipients; the Swiss rescue of UBS was in part for the benefit of its US businesses.

Regulators could instead insist that all financial firms operating in their country have enough capital in that national entity (no parent guarantees) to satisfy local rules. This would effectively require banks to start segregating their operations on a country-by-country basis (each would presumably need to have its own Treasury operations, for instance, which still could coordinate with a regional or global treasury function). It would also make national regulators far more attentive to the size of the banking system relative to their economy and give them incentives not to have an outsized banking sector. Having banks more compartmentalized by country would make them far easier to resolve and reduce the need for global coordination (the sort of US-UK misunderstandings that scotched the last-ditch effort to rescue Lehman, for instance).

Now admittedly, finance has evolved in such a way as to defy this template. The biggest firms have trading books that they manage on a global basis, and Citibank had a global payments business that would be very hard to house in nation-based banking regimes. But quite a few businesses can be hived out and operated on this basis (retail and institutional lending, private equity, for starters) and any steps to build more buffers in the banking system and make it easier to wind down banks would be a considerable step forward.

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11 comments

First thing first, they better insist bank to stop speculating with multi trillion dollar fresh cash in commodity, specially basic need. Wheat, rice, cotton, sugar, oil, etc. Or else this will be a repeat of 2008 food stuff spike that cause riot all over the globe.

Yves,
Having worked for 2 of these institutions in the past 28 years, I think the idea of a global regulatory power is a great idea, albeit very naive. Country regulators look at their banks as “national champions”. This is a very ingrained mentality. Deutsche Bank, for instance now only makes 25% of their revenues in Germany, ten years ago it was 75%. Put simply, they are NOT a German bank. Citibank stopped becoming a US bank many many years ago, as its focus has always been following big companies overseas. BAC, however, IS a US bank with 90% of it’s business in the U.S. HSBC is NOT a UK bank, they are a HK/Chinese bank with an Asian “inner circle” and a European “2nd string” circle. The list goes on.

So the first thing to know is who are you regulating. The second thing is “what”. The blow ups we have seen which contribute to the social costs is almost entirely related to trading and position taking, not the boring old stuff of actually banking. Regulating the boring stuff is really easy and could be streamlined much more, but it won’t save social costs.

Regulating the double back flip triple twist CDS, HFT desks, “don’t you dare book that asset on our books” so-called “banking” is where the problem is. There is a much more simple solution to this problem that forming some kind of galactic super regulator: ban it. Cut out the virus that creates all the social costs. Ban HFT, force banks to carry assets at market value, throw crooks in jail etc. This can all be accomplished with the regulators already in place, if they would simply do what they are paid to do.

Systemic risk is always there, whether you have 10 mega banks or 100 medium sized banks. Reducing risks is a simple act of forcing banks to behave like they are supposed to.

That’s pretty much what Volker and the “Group of 30” said when they were put together back in 2008 to study the crisis.

Since then, we have discovered there are holographic CDS, black holes may exist inside MBS, HFT can be blue shifted or red shifted when bids are followed by cancellations at the speed of light, the uncertainty principal can be applied to proprietary trading resulting in a rebranding of the activity, and the Fed and Treasury have merged and are now known as Uncle SIV.

Oh yes, and the derivatives market is still something like 10X global GDP.

And large bank balance sheets, with the approval of regulators, make Enron and Worldcom look like a bunch of girl scouts. The rest of the non-financial biz world still toils under Sarbanes-Oxley.

Why regulators and lawmakers anywhere can’t seem to address any of these things is quite a mystery.

We don’t need new regulation. We need a bailout of the population with new debt and interest free legal tender fiat, United States Notes, combined with leverage restrictions on the banks to preclude inflation followed by fundamental liberty in private money creation.

What is our current system? Is it not that banks can create the government enforced monopoly money out of thin air in exchange for dubious assets? Is that not counterfeiting by another name, commercial banking?

Go ahead and re-regulate the system if insist. And what principles will you use? Too big is bad? And where will the line be drawn between too big and not?

When will we learn that a money system based on theft of purchasing power shall not stand? Or is God mocked?

Through a slit in the vortex,
You can see,
The great,
The all pervading,
Central bank controller,
The womb of the onotron,
With its,
Miles of wires,
Connecting its jillions,
Of computer controlled circuits,
One for each being on the planet,
Used to meter out individual liquidity,
And on any given second,
They can pump you full of debt,
Or suck out all your cash,
And squash you,
Like a lowly meal worm,
And you gave them their power,
With your own lies …

I just read Taibbi’s Griftopia and he entertainingly refers to Goldman Sachs as a Vampire Squid. Yves and others refer to our financial class a banksters. These are interesting metaphors with good emotional resonance but they don’t seem to me to be informative enough.

When I look at the at how much of our financial system currently operates I see nominally independent mobile and self centered actors roaming the landscape looking for and finding opportunities to perform extractions. Our legal system can barely even recognize their extractive activities and can apply no significant restraints.

Only one word needs to be changed in the above description, legal -> immune, to provide a nearly exact description of a late stage highly aggressive cancer that is dropping metastic lesions all over the body.

When viewed this way David Stern’s foreclosure operation in Florida, the parking meters in Chicago, and Jefferson Counties derivatives problems are just mets that haven’t achieved full invisibility. I suspect in each of the above cases the financial actors extracted more than 100 million dollars.

We can see how the cancer’s ability to increase its extractions and evade the legal system has evolved over time. In the late 80’s 1000 bankers went to jail in the wake of the S & L crisis. After the dot com bust 10’s of executives went to jail. After the 2008 crisis 1 financial actor has gone to jail (Madoff for his ancient fraud).

The thing about cancer is once the tumor load gets to high death occurs. And once the immune system can no longer recognize or act against the cancer the only treatments available are radiation or chemotherapy which act by killing growth.

All is not lost for Roosevelt dealt with a similar situation by rebooting the money supply in a form that removed the cancer of the 20’s oppportunities for growth and spread.

Mobile, growing, and unregulated selfish actors opporating in a society is the definition of cancer.

Repeat after me: the global, monetarist financial system is dead. No global oversight now will change this fact. Much like FinReg demonstrated, closing the barn door after the horses have bolted is an exercise in inept cowardice.

So called “regulatory authorities” can pretend all they want that, status quo arrangements over the past forty years somehow can be reinforced by yet another round of fiat amounting to so many empty words by a long-standing lack of any meaningful oversight and a pervasive, badly confused sense of “economy” rationalized with much sophistry (more or less the trend since the destruction of the Bretton Woods agreement). However, the volatile combination of billions of expectant lives oppressed by a grossly imbalanced physical and financial economy advises soon-to-be imperialist has-beens to start talking about how a growing body of insolvent financial claims will be removed from the equation, and how a physical economy running way below break-even will be resuscitated. At this late hour that finds circumstance remaining relatively calm the last opportunity to maximize the number of interests remaining vital going concerns is at hand.

Either a Great Global Restructuring employing principles at the heart of the American System of Political Economy rapidly ascends — uplifting nation states everywhere — or the globe is sure to descend into hell.

Nassim Taleb in an addendum to his opus magnum remarked
in a chapter titled ‘Ten lessons to live in a black-swan
free world: ‘In the U.S, during the 2000s, the banks took over the government.This is surreal’.The description could
be extended to the global governance, a great victory for the
IIF, the international banking lobbying’s arm.
We were given to see the ‘amazing results’of cross-border national regulators during the European stress stest, and
the creation of a cross-border regulation bodym run out of Brussels, and presided by JC Trichet, expected to be composed of approximately 60 members, every European central banker and his wife, approximately. This defeats the purpose, The FSB was a great idea, such a body is highly necessary, Simon Johnson was forward-seeing when he diagnosed it would be watered down. I am absolutely amazed
that they managed to ‘capture’ Adair Turner,appointed as chairman of the FSB in november 2008 ( FSB now chaired by Mario Draghi, ex- Goldman boy, this may explain that )
whose position is on the same line as Yves’s.

Thanks for the link to the Haldane paper – its one of his I’ve somehow missed. He seems to be one of the very few on the “official” side of the bankster debate to (a) really stick his neck out on the destructive power of the TBTFs and (b) have the writing/polemical skills to make the case stick.